Counter arguments to the critics of modern monetary theory (MMT)

In recessions, the US (the Fed) lends to the US (the government) to achieve the dual mandate of the Fed, full employment and price stability.

According to the Federal Reserve Act, the Fed can only lend in return of treasuries or government-sponsored mortgages.

The Act guarantees the Fed's purchase of treasuries until an inflation at the target. The Fed thus finances the government's issuance of treasuries in a recession.

Compared to the massive corporate bond purchases, a central bank's funding of the government spending would require a much smaller growth in the central bank money.

1) Federal Reserve Act requires the Fed to finance government.

Critics disagree with the MMT position that a country self-funds itself in a recession. In fact, the Federal Reserve Act leaves the Fed with no other option other than financing government spending. According to the Act, the Fed can only lend in return of treasuries or government-sponsored mortgages ( guaranteed by government sponsored enterprises, Fannie Mae and Freddie Mac). That is, the Fed's purchase of treasuries is guaranteed until an inflation at the target. Thus, the Fed finances government's issuance of treasuries in a recession. In other words, the US (the Fed) lends to the US (the government) to achieve the dual mandate, full employment and price stability.

2) Not only public debt but also private debt raises risks.

MMT critics argue that a higher public debt-to-GDP ratio raises concerns about a government's solvency. Proponents of this argument should acknowledge that not only public debt but also private debt raises fragilities in the financial system. The current monetary policy has been piling on private debt through asset purchases since the 2008 financial crisis. Central banks have lent trillions of dollars to businesses. High leverages hence exacerbate financial crises due to borrowers' overreaction to output deviations. As a result, governments will step in and bail out corporations via taxpayers' money.

An anti-public debt position requires to be against all debt. When authorities limit leveraging through macroprudential tools, they will need to restore the fall in debt-based spending via creation of new income. In a world where new debt is not an option, the only way to create income is typing money. A central bank can produce and transfer money to beneficiaries by debiting an account called ''transfers''. Thus, a country would raise income without creating new debt.

3) Raising public debt is the most efficient way of boosting demand.

Critics argue that monetization of government spending would enormously expand a central banks's balance sheet. The rise in central bank money depends on monetary tools' ability to foster spending. Lending to businesses does not ensure more spending whereas new public debt does. QE fuels central bank balance sheets since businesses are reluctant to spend. Monetization of public debt would boost spending 100% and enable recovery as governments spend new resources to enhance expenditure. Compared to the massive corporate bond purchases, a central bank's funding of the government spending would thereby require a much smaller growth in the money supply.

4) Would inflation pose a threat?

Critics worry about hyperinflation if the constraints on public debt does not exist. Such a concern is not baseless. Governments need short-term successes to win the next election. Inflation emerges with a lag after the output growth. Prior to elections, governments would be willing to raise spending via additional debt even though inflation exceeds the target. Thus, they would transfer the burden of fighting inflation to the prospective government.

Nevertheless, all these drawbacks exist in the status quo. As long as governments issue debt, they can raise public spending. This is why countries have integrated central bank independence in their legal economic infrastructure. A central bank would prevent a fiscal inflation rally by raising the funding rate and restraining leveraging.

Conclusion

Modern monetary theory does not propose but sets forth the mechanism of self-funding. It is surprising that some critics have not been aware of this reality so far. Central banks universally accept the treasury bonds of their countries as collateral. To extinguish crises, they exercise massive treasury purchases. They had to extend their collateral schemes once governments did not issue ample debt during recessions. The practice of corporate asset purchases is a consequence of countries' not self-funding themselves due to conservative fiscal policy.